Leaping ahead in Netherlands, sliding backwards in Manchester

Pay As You Drive road pricing is closely related to PAYD insurance. Both are instruments that public policy makers can use to improve congestion, road usage and the costs associated with it. The concept of road pricing is charging road use on a usage base, and using the pricing to control or curb congestion. A good example of it is the inner London flat fee when you drive into London. A crude but effective way of making you think before you jump into your car and drive into London (like the traffic isn’t enough).

The problem with road pricing is that it is highly unpopular. I am always amazed that a change in toll fees for the cross-city tunnel in Sydney makes front-page news for a week (page 16 has children dying by the millions due to the Food Crisis). The voting public hates it when something they have for free suddenly has a price on it. And that is the problem. It is politically challenging for a politician to introduce sound policy in this space, particularly when people have to pay for it.

Two recent examples of success and failure are in the Netherlands and Manchester. In the Netherlands they announced a bold and spectacular program to get every car wired by 2016 and have accurate road pricing, linked to type of road, time of day and type of vehicle. PAYD insurance is so obvious once you’ve made that mind shift. Add to this the fact that the Netherlands has the highest use of bicycles in the world (having no hills has its advantages…), and you have a society where transport is going to be seriously responsible.

Contrast that with Manchester, where a public referendum said no in very certain terms to a road-pricing scheme), to the tune of 4 to 1. It is being heralded as the last rites to road-pricing (and slated as being a major step backwards for the Government (who established a multi billion dollar fund to support this) and for other cities with similar plans.
It will be interesting to understand the dynamics of how the Netherlands went about it, and what the factors were that made it successful, versus the Manchester stuff-up.

So what’s the solution to the Multiple Prisoners’ Dilemma?

Following the post on Multiple Prisoners’ Dilemma (see 22 November post), Justin Horner wrote to me and said I cannot just state a problem without stating the solution. Fair point. I don’t have the solution, but I can suggest some solutions:

1. From a Regulatory perspective the US is a fascinating place (in a morbid sort of way). It is legislated for example how you rate, meaning which rating factors you must use and what weights they must carry. So the easiest solution is: Mandate PAYD through regulation. Although it has been raised as a possibility in California, I think it is unlikely to happen though, and will definitely not happen here in Australia.
2. The Government and Regulators can do a few other things too. One of these is to waive taxes and duties on PAYD premiums. In Australia for example premiums are loaded with GST, Stamp Duty and in some states a Fire Services Levy. Waive these on PAYD policies and make them even more compelling for low mileage drivers. The tax revenue argument to justify this is that low mileage drivers are over paying for road usage anyway through normal taxation methods and car registration fees. Another argument is that it will shift people into PAYD quicker, meaning less driving (see 31 July 2008 post for the Brookings Institute paper on the impact of PAYD), resulting in lower cost of infrastructure for the Government, offsetting the lower tax collections on these policies. This will stimulate the market forces through increased consumer demand, which will in turn bypass the Prisoners’ Dilemma. There are a few other government interventions. The aim is to make the cost of car ownership as variable as possible. If car ownership becomes more variable, people will drive less, which will make PAYD insurance even more attractive. There are two sides to this, described in 3 and 4 below. 
3. Make the existing fixed existing cost variable. The prime examples of this in Australia are annual registration fees, which runs into a few hundred dollars, and compulsory third party (CTP) liability insurance, with currently regulated pricing. Clearly low mileage drivers are getting a raw deal on CTP. 
4. Toll the roads. If I drive down to the local supermarket (or almost anywhere in Sydney, as long as I avoid the bridge and some of the motor ways) it does not cost me anything. And yet I am using something that costs money to maintain. I should be paying for it on a usage basis, as opposed to a taxation basis where my usage has no bearing on what I pay in taxes. So if there is a direct correlation between my driving and the cost of using the road, I will no doubt be more responsible. I will drive less, which will in turn make PAYD insurance even more attractive. The second aspect of this is that technology is required to do accurate tolling. This is where PAYD and tolling at least in theory can meet. All PAYD products (other than Real Insurance and Milemeter) uses a form a telemetry. That can double for tolling. It won’t be politically popular, but it will work.
5. The Government can offer insurance companies incentives. These incentives can be targeted to ease the cost of system and product development, roll-out of telemetry for PAYD solutions requiring telemetry or even assist with promotion. The political endorsement and promotion does not cost any hard dollars, and can do a lot to stimulate the development of the product. A framework around this is suggested by Jason Bordoff and Pascal Noel of the Brookings Institute.
6. There are also things insurance companies can do to solve their Prisoner’s Dilemma. Looking from the outside at what Progressive has done, I suspect their angle of attack is to offer a voluntary product where people get adjustment on their future premiums based on their driving in the past. This is a reasonably “soft” way of introducing it into an existing portfolio, and time will tell how successful it will be.

What will be great is to see politicians and regulators getting engaged on the topic, and stimulating the development of PAYD. Everyone is watching Steve Poizner (Commissioner of Insurance in California), who is actively developing policy for California around Pay As You Drive. Many of the US states are watching and waiting to see what happens in California before they act. Hopefully Mr Poiznier will have the courage of his convictions to do something incisive and robust. We wait with interest.

In Australia, where we have an up and running product working really well, there has been no government interest to date. We live in hope.

A Multiple Prisoner's Dilemma

The concept of PAYD, or usage based pricing for car insurance has been around since 1920. The following is an excerpt from an email sent to me by Patrick Butler, Insurance Project Director at the National Organization for Women:

"The audited odometer mile exposure unit has been available for commercial fleets since at least the 1920s, was discussed by 1996 Nobel laureate economist William Vickrey in a 1968 paper, was the subject of a sex-discrimination lawsuit brought in 1986 by Pennsylvania National Organization for Women and documented in three Journal of Insurance Regulation (JIR) papers in 1988 and 1989, was described as the basis for an efficient pre-paid-miles personal car odometer system in a 1993 CAS Forum paper to support exposure unit legislation introduced in Pennsylvania 1990-1993, and so on.

All of these items are documented by papers and reprints available on the website www.centspermilenow.org."

So why is it taking so long for insurers to adopt Pay As You Drive. Progressive in the US had a pilot called Autograph in 1998. That is 10 years ago! Either the concept is flawed, or there must be another reason. 

In terms of the concept being flawed: The concept of PAYD will be flawed if there is no meaningful relationship between how far a person drives, or how they drive, or where they drive, and the amount of risk they bring to the risk pool. The possibility of there being no meaningful relationship is counter-intuitive, but nevertheless possible. Published results of Progressive's Autograph pilot in Texas indicates a clear relationship between distance driven and risk. Furthermore, traditional insurance pricing does its best to capture driving behaviour, by looking at factors like age, gender, vehicle modifications, etc as proxies for risk. So it is unlikely that PAYD is not taking off due the concept being flawed. There must be some other reason. I believe there are two major reasons, and a number of smaller ones. This post deals with the first reason (Prisoner's Dilemma). The second big reason I believe is systems, and will be discussed in a future post.

Multiple Prisoner's Dilemma:

The concept of Prisoner's Dilemma is a classic game theory problem. The basic prisoner's dilemma is explained quite well in Wikipedia. What does that have to do with PAYD? 

To answer this we need to look at the basic premise of the product: In traditional insurance, people who drive less, pay the same as people who drive more (all normal rating factors assumed to be the same). The reason for this is that traditional rating factors (age, gender, suburb, car make and model, claims experience, etc.) are crude proxies for the true underlying risk. Insurance companies have not used mileage actively as a rating factor, because of the difficulty of verifying mileage (mileage as a rating factor is mandated by law in California, but is not checked by insurance companies and a consumer can frankly declare whatever they want). So PAYD introduces accurate pricing for mileage, and by doing so low mileage drivers can receive a more accurate and fair premium.

If you are an existing insurance company with a large book of existing car policies, you most likely have a finely balanced book that is profitable, albeit with thin margins. Your pricing is working, and the cross-subsidies between high mileage and low mileage drivers are balanced. If you introduce PAYD you will charge low mileage drivers less (and a fairer price) and high mileage drivers more. High mileage drivers will most likely leave you and take insurance from someone else who still provides traditional insurance. As an insurance company you face the prospect of losing a large part of your book before you can replace it with low mileage drivers (where you are in fact competitive). That is a daunting prospect. You have a large infrastructure in place which you've built up painstakingly and which is well matched to your current size and volume. If you lose material volume your expense ratios will blow out, which will in turn very quickly eat through your thin margins, leaving you unprofitable. That is not an appetising scenario for any insurance executive.

So this is where the multiple prisoner's dilemma comes in. If nobody acts (i.e. nobody offers PAYD), then status quo remains, books remain finely balanced and life goes on. The first large player to offer it faces the uncertainties listed above, and may take some short term strain. After the short term strain however, the first mover(s) will start benefiting from attracting more and more low mileage drivers and having a competitive offer for arguably 50% of the market. 

What does that do to the other companies? As their low mileage drivers start abandoning them, their book becomes unbalanced. They have less low mileage drivers to cross-subsidise their high mileage drivers. Over time their margins will erode, and arguably in time they will be forced to switch to PAYD.

The Prisoner's Dilemma is not a trivial problem for existing insurers to overcome, and I think it will take many years for them to do so.

PAYD Webinar archive

On the 5^th of November the National Underwriter hosted a webinar on Pay As You Drive, titled:

PAY ONLY AS YOU DRIVE INSURANCE COMING READY OR NOT

What Are the Business, Technology and Regulatory Realities You Need to Know?

It was attended by 280 people, mostly based in the US. Most of the major carriers were represented, as well as state regulators and consumer groups. The archive of the actual webinar can be found on http://www.summitwebseminars.com/exigen/Pages/default.aspx.

 

Some coverage for Pay As You Drive in The Australian

The article below appeared in the Australian today.

Source: http://www.theaustralian.news.com.au/business/story/0,28124,24546649-5001942,00.html

A car insurance product

What's new | October 29, 2008

What is it? A car insurance product which the promoters say could significantly reduce a person's premiums.

Pay As You Drive from Real Insurance allows qualified motorists to pay only for the kilometres they plan to travel.

What are its features? Pay As You Drive allows motorists to cover their vehicles based on how far they drive. Motorists can buy kilometres and are covered until they complete that distance. Anyone driving less than the average for people with the same insurance profile should pay less than they would for traditional comprehensive car insurance. Those who qualify get comprehensive car insurance with a minimum annual premium and purchase insurance for the kilometres they expect to cover in that vehicle. Unused kilometres never expire -- they can be transferred year to year or be refunded and customers who are about to run out of kilometres can apply to purchase additional kilometres. Pay As You Drive reminds customers when they may need to top up their kilometre balance with a sticker for their windscreens and SMS messages to their phones. People who have not made a claim against any of their Pay As You Drive policies for three years in a row receive 10 per cent of the total premiums paid in that time. Similar insurance products overseas require policy holders to have their vehicles equipped with monitoring devices. Pay As You Drive in Australia relies on the customer reporting the odometer reading of the vehicle insured.

What are the advantages? Pay As You Drive is suited to people who drive to and from the train station or work close to home and perhaps use their cars on weekends. It also suits those who have a second or third car.

What are its disadvantages? Pay As You Drive is not for everyone. It works for people who drive less than average. Motorists who drive a lot are actually being subsidised by traditional car insurance, so Pay As You Drive won't work for them. Pay As You Drive is available only to drivers over the age of 25.

What does it cost? Pay As You Drive claims cost savings of "up to 60 per cent on car insurance per annum". A 29-year-old Parramatta man who owns a Mitsubishi hatchback would typically pay $981 a year for insurance, but if he only drives 5000 kilometres, he would pay $316 per year with Pay As You Drive.

For more details, visit  www.payasyoudrive.com.au

Webinar on Pay As You Drive Insurance on 5 November 2008 2pm ET

The National Underwriter, in conjunction with Real Insurance, Exigen Insurance Solutions and Tower Group is putting on a webinar on PAYD. The details are below:

• Date: November 5, 2008
  
•  Time: 2:00 p.m. ET
  

http://www.summitwebseminars.com/exigen/Pages/default.aspx

Pay Only As You Drive Insurance Coming Ready or Not

What Are the Business, Technology and Regulatory Realities You Need to Know?

 
 

Are you ready for the coming auto insurance revolution?

Low mileage driver interest in pay-only-as-you-drive insurance (PAYD) is growing fast, for many reasons. It will save most drivers money on their premiums. And it is environmentally responsible - a green product that creates incentives for driving less, resulting in less pollution, oil dependence and infrastructure cost. So why are some U.S. insurers moving fast while others are slow to act?

Get answers to the important questions:

• What is the market?
  
• Is consumer privacy an issue?
  
• What are the business barriers?
  
• What are regulators doing?
  
• What are the technology options and barriers?
  
  

Plan your company's next steps toward a fast emerging new auto insurance product. 

Moving to mileage-based coverage as a term of insurance has rating and pricing implications and it challenges conventional policy administration, claims, billing and other systems. Find out how Real Insurance, a division of Hollard Australia, implemented the first PAYD product not requiring a monitoring device within customers' vehicles - a solution that avoids consumer privacy issues. Hear all sides of the issue and make your plan of action.

Featured speakers:

• Roger Grobler, CEO, Real Insurance, a division of Hollard
  
• Karen Pauli, Research Director, Insurance,
  TowerGroup
  
• Fazi Zand, VP, Marketing & Business Development, Exigen Insurance Solutions
  

 
 

Pay As You Drive wins best general insurance product in Australia “

Real Insurance won the best general insurance product at the ABF awards for Pay As You Drive. We're very pleased about this, particularly because the product was only recently launched. It is quite an honour to win the award against all other general insurance products in a very competitive market, and I think it recognises the fact that the product is truly innovative and a great deal for consumers.

Channel 9's Extra program has also filmed a segment on Real's PAYD over the last few days. Extra is Channel 9's Queensland based lifestyle program. The segment is expected to go to air over the next few weeks.

An excerpt from the press release following the award below:

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Pay As You Drive from Real Insurance, the first insurance product of its kind in Australia whereby qualified motorists pay only for the kilometres they travel, has won The Best General Insurance Product category at the Australian Banking and Finance Magazine Telstra Insurance awards.

Says Real Insurance CEO Roger Grobler: "Pay As You Drive gives people a fair go on their car insurance. We wanted to offer Australians a product which reflects large scale changes in their motoring habits and one which would accommodate these changing needs.

"We recognised that current car insurance is unfair to people who use their cars sparingly. The result is that Pay As You Drive offers people who drive less than the average for their age, gender and area to pay only for the kilometres they drive."

Grobler says that the way the current car insurance system is structured means that low-mileage drivers are simply subsidizing insurance costs for high-mileage drivers.

"We wanted to change that so if for example you drive to and from the train station, or work close to home, or you use your car a bit on the weekend, or you have a second or third car, it is likely that Pay As You Drive will save, in some cases quite dramatically, on your car insurance premiums," says Grobler.

The awards were mediated by a panel of leading insurance industry experts including former Suncorp Insurance boss, Diana Eilert, senior Moody's analyst, Wing Chew and top UBS analyst, Ralph Butterworth.

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